Hello, I’m Javier López, Fixed Income Specialist @ Axxets Wealth Management.
With interest rates on multidecade highs and fixed income expected to show interesting returns in the short/mid-term. We deem it important to explain how bonds work, as this is a $130 trillion market vs the $109 tn market for equities.
What are bonds?
In a nutshell, when you buy bonds, you’re providing a loan to the bond issuer, who has agreed to pay you interest and return your money on a specific date in the future.
Companies sell bonds to finance ongoing operations, new projects, or acquisitions. Governments sell bonds for funding purposes, and to supplement revenue from taxes. When you invest in a bond, you are a debtholder for the entity that is issuing the bond.
Bonds, especially investment grade, can help hedge the risk of more volatile investments like stocks, as they stand higher in a company’s capital structure.
Key terms for understanding bonds
- Maturity: The date on which the bond issuer returns the money lent to them.
- Face value: Is the amount your bond will be worth at maturity. A bond’s face value is also the basis for calculating interest payment. Most commonly bonds have a par value of $1,000.
- Coupon: The fixed rate of interest that the bond issuer pays its bondholders on an annual basis. Using the $1,000 example, if a bond has a 3% coupon, the bond issuer promises to pay investors $30 per year until the bond’s maturity date. The higher the coupon, the higher the credit risk the bond is exposed to.
- Yield: The rate of return on the bond. While coupon is fixed, yield is variable and depends on a bond’s price in the secondary market and other factors.
- Price: In the market, bonds have two prices: bid and ask. The bid price is the highest amount a buyer is willing to pay for a bond, while ask price is the lowest price offered by a seller. The price is shown as a % of the Face Value.
- Duration risk: This is a measure of the sensitivity of the price of a bond as yields fluctuate. There is an inverse relationship, if yields go up, prices go down. The longer a bond’s duration, the higher exposure its price has to changes in interest rates.
- Rating: Ratings agencies, like S&P, Moody’s and Fitch, assign ratings to bonds and bond issuers, based on their creditworthiness. This is: how well companies or sovereigns are positioned to timely fulfill their financial obligations. Bond ratings help investors understand the risk of investing in bonds.
Stay to learn more about the types of bonds, and how they are priced. And remember that, at Axxets, our greatest interest is you.
Hello again Mr. Bond (Pt. 2)
Hi, I’m Javier Lopez, fixed income specialist at Axxets Wealth Management. In our previous clip we defined what bonds are and their key terms. Making this clear, let’s move on to the types of bonds and the factors that affect their price.
We can further classify bonds according to the way they pay interest and certain other features:
- Zero-Coupon Bonds: As their name suggests, do not make periodic interest payments. Instead, investors buy zero-coupon bonds at a discount to their face value and are repaid the full face value at maturity. Treasury bills and CETES in México are Zero-coupon bonds.
- Callable Bonds: These bonds let the issuer pay off the debt—or “call the bond”—before the maturity date. Call provisions are agreed to before the bond is issued.
- Puttable Bonds: Investors have the option to redeem a puttable bond—also known as a put bond—earlier than the maturity date. Put bonds can offer single or several different dates for early redemption.
- Convertible Bonds: These corporate bonds may be converted into shares of the issuing company’s stock prior to maturity.
How are bonds priced?
Bonds are priced based on their face value, or par. Bonds that are priced above par are said to trade at a premium, while bonds that are priced below their face value trade at a discount. Like any other asset, bond prices depend on supply and demand. But credit ratings, market interest rates and other macro variables play big roles in pricing, too.
Therefore, investors should work with their financial advisor to help select bonds that provide income, tax advantages and features that make the most sense for their financial goals.
- Bonds are investment securities where an investor lends money to a company or a government for a set period of time, in exchange for regular interest payments as well as repayment of principal at maturity.
- The price of a bond is influenced by the issuer’s creditworthiness, as well as market developments, such as interest rate dynamics.
- Fixed-income investments should be a core part of your investing strategy, as bonds can provide both stability and predictable income.
- Therefore, investors should work with their financial advisor to help select bonds that provide income, tax advantages and features that make the most sense for their financial goals.
In Axxets, our greatest interest is you.